Provident Financial Services, Inc. — Q3 2018 Form 10-Q
Business context and period. The company and its wholly owned bank reported unaudited consolidated results for the quarter and nine months ended September 30, 2018. It is a regional banking business; interest income and expense are its primary revenue drivers. Comparisons below are with 2017 for operating results and December 31, 2017 for balance-sheet changes.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $75.8 million | $70.2 million | $223.3 million | $206.3 million |
| Provision for loan losses | $1.0 million | $0.5 million | $21.9 million | $3.7 million |
| Non-interest income | $15.9 million | $15.1 million | $43.1 million | $42.4 million |
| Non-interest expense | $46.7 million | $46.3 million | $142.4 million | $139.7 million |
| Net income | $35.5 million | $26.6 million | $82.6 million | $74.5 million |
| Diluted EPS | $0.54 | $0.41 | $1.27 | $1.15 |
| Net interest margin | 3.38% | 3.22% | 3.33% | 3.19% |
Financial condition, cash flow and capital
- At September 30, total assets were $9.71 billion, down $135.6 million from year-end 2017. Gross loans were $7.23 billion, down $97.3 million; deposits were $6.72 billion, up $5.6 million.
- Cash and cash equivalents were $149.1 million, versus $190.8 million at year-end. Borrowed funds declined $212.6 million to $1.53 billion. Stockholders’ equity was $1.33 billion, up $32.9 million.
- For the first nine months, operating cash flow was $132.8 million, investing cash flow was $73.9 million, and financing cash flow was negative $248.3 million; cash declined $41.7 million.
- The allowance for loan losses was $53.9 million, or 0.75% of loans, compared with $60.2 million, or 0.82%, at year-end. Non-performing loans were $29.1 million (0.40% of loans), and non-performing assets were $35.0 million (0.36% of assets).
- Bank actual capital ratios included 9.68% Tier 1 leverage, 11.88% common equity Tier 1 and 12.59% total risk-based capital. The filing states the Bank exceeded applicable minimum requirements.
Material changes and management commentary
- Q3 net income rose about 33% year over year, while nine-month net income rose about 11%. Management attributed stronger earnings to lower federal tax rates, growth in average loans and non-interest-bearing deposits, and improved net interest margin.
- Net interest margin increased 16 basis points year over year in Q3 and 14 basis points for the nine-month period. Higher earning-asset yields outpaced rising funding costs; interest expense also increased.
- Nine-month provision expense rose sharply to $21.9 million, and net charge-offs increased to $28.2 million from $5.3 million. Management said charge-offs were largely affected by write-downs of certain asset-based loans; the allowance reduction reflected asset-based loan sales and improved credit quality in the remaining portfolio.
- Loan balances contracted amid elevated payoffs and loan sales, including the wind-down of the asset-based lending business. Commercial real estate, commercial and construction loans comprised 78.5% of the portfolio at quarter-end.
- Core deposits declined $37.5 million while time deposits increased $43.0 million, partly due to a 13-month CD promotion intended as a lower-cost alternative to wholesale borrowing. Borrowings fell as asset-funding needs declined.
- Q3 effective tax rate was 19.5%, versus 31.1% a year earlier; the nine-month rate was 19.1%, versus 29.3%. The company attributed the reduction to the Tax Cuts and Jobs Act.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management cautions that interim results are not necessarily indicative of full-year results.
- Interest-rate exposure is material: the company’s model projected a 4.2% decrease in 12-month net interest income under a gradual 300-basis-point rate increase; an immediate, sustained 300-basis-point increase projected a 12.9% decrease in economic value of equity. Management notes model assumptions and actual outcomes may differ.
- Available-for-sale securities had $30.6 million of gross unrealized losses at September 30, compared with $10.1 million at year-end; accumulated other comprehensive loss increased to $24.6 million. Management attributed the rise in securities in loss positions to higher market interest rates and concluded the losses were not other-than-temporary.
- The expected-credit-loss standard (CECL) was not yet adopted. The company was implementing it and could not reasonably estimate its impact; management noted adoption may increase the allowance. Lease-standard adoption was planned for January 1, 2019, with impact still under assessment.
- Management identified economic weakness, real-estate value declines, unemployment, commercial-property vacancies and interest-rate changes as risks to borrower repayment and future credit provisions. Legal claims arising in the ordinary course were not expected to materially affect financial condition.
Important facts for investors to verify
- Whether elevated asset-based loan charge-offs and the large year-to-date provision represent a contained portfolio clean-up or ongoing credit deterioration.
- Subsequent trends in criticized loans, delinquencies, non-performing assets, charge-offs and allowance coverage.
- Whether margin gains persist as deposit and borrowing costs rise, and how deposit retention and funding mix develop.
- The sensitivity of earnings and capital to interest-rate movements, including the assumptions behind the company’s simulation models.
- The eventual CECL allowance impact, and the effect of unrealized securities losses if liquidity needs require securities sales.